Growth and Reform in Russia -- Address by Anne Krueger, First Deputy Managing Director, IMF
March 20, 2002Growth and Reform in Russia
Address by Anne Krueger
First Deputy Managing Director
International Monetary Fund
Conference on Post-Communist Economic Growth
Moscow, March 20, 2002
It is a great pleasure to be here today and to be participating in this conference.
All the more so because we are gathering at a time when the Russian economy is performing impressively in a difficult external environment. The authorities have established a track record of strong macroeconomic management, combined recently with a welcome acceleration in the pace of structural reform. With the help of higher energy prices and the impact of the 1998 devaluation, their virtue has been rewarded with three years of strong economic growth. Maintaining the momentum of reform holds out the promise of stronger growth and continued stability in the future.
What I would like to do today is talk briefly about recent developments in the economy, before asking what Russia should be aiming for in terms of long-term growth performance, and how to achieve it. The bottom line is that Russia is very much on the right track. The key is to entrench and extend the current reform agenda, and to ensure that vested interests are not allowed to stand in the way of delivering strong and sustainable improvements in living standards for all Russia's citizens.
2. Recent Performance
Although economic growth slowed significantly, to around 5 percent last year, this was still an impressive outturn and better than either we or the authorities had predicted earlier in the year. Domestic demand was the engine of the expansion, fuelled by buoyant consumer confidence and a recovery in real wages. Growth has helped cut unemployment by almost a third over the last two years, to less than 8½ percent. Admittedly, employment growth has lagged the increase in GDP, as labor hoarding from earlier years has unwound. But the resulting rise in productivity has helped cushion corporate profits as real wages have risen and the ruble has strengthened in real terms.
Meanwhile, the fiscal position has continued to improve, and not just because of buoyant economic activity. Greater tax compliance has lifted revenues to their highest level since the dissolution of the Soviet Union. And yet spending has been commendably restrained. As a result, the federal government's primary budget balance — adjusted for oil prices — improved by more than 1 percent of GDP last year.
The external position also remains strong, with the current account surplus narrowing (thanks to higher imports) but remaining very large at 12 percent of GDP. This has allowed Russia to accumulate official reserves and pay off borrowing from the Fund ahead of schedule. Large surpluses are a mixed blessing, however. The use of partially sterilized intervention to limit the ruble's strengthening has fuelled money growth and prevented inflation from falling in line with the authorities' target.
Looking forward over the near term, domestic demand should continue to grow strongly, driven by consumer spending and (to a lesser extent) investment. GDP growth is likely to dip below 4 percent this year, but pick up again slightly in 2003 as the global economy regains momentum. The current account surplus should narrow significantly again this year, while the capital account strengthens as net private outflows decline and as Russia returns to the international capital markets.
All in all, policymakers have good reason to be satisfied with the current situation. Fiscal consolidation and the strong external position have helped insulate Russia from pressures afflicting other emerging market economies. Together with structural reform and greater political stability, the stronger macroeconomic position has boosted investor confidence. This has been reflected in big stock market gains and narrowing spreads on sovereign bonds. Russia has not been the only beneficiary — growth and stability here have helped support recovery throughout the region.
3. What Should Russia Aim For?
Given this favorable starting point, what should Russia be aiming for in terms of longer-term growth performance? Within 10 to 15 years, we believe that Russia should be on a "steady state" economic development path similar to that of the advanced transition and emerging market economies. Over the last 20 years, growth in these economies has generally been in the range of 4 to 6 percent a year, except during the financial crises of the late 1990s. Advanced transition economies managed to secure growth rates like these even during the late 1990s, with improvements in total factor productivity accounting for about half the gain each year.
Various studies have analyzed the growth performance of transition economies, using a variety of explanatory variables. Among them: initial income; physical investment; investment in human capital (using primary and secondary school enrollment as proxies); population growth; and government consumption. These studies suggest that potential growth of 5 to 6 percent a year would be a reasonable long-term goal.
Resource rich economies have tended to grow a little more slowly, other things being equal. But this would likely be offset in Russia's case by the benefit of a relatively educated population. For example, Russia's 90 percent primary school enrollment rate is in line with the average for fast-growing comparator economies and almost twice that of slow-growing ones. In secondary education, Russia is streets ahead — at three times the average for fast-growers and nine times the average for slow-growers.
If Russia is to sustain GDP growth of 5 to 6 percent a year over the longer term, with half generated by total factor productivity growth, what does this require in investment? Over the last 20 years, gross investment has typically ranged from 15 to 20 percent of GDP in emerging market economies. But the figure has been higher for advanced transition economies: 20 to 25 percent of GDP for private investment; plus another 3 to 6 percent in public investment. Given a realistic assessment of its capital-output ratio, Russia needs to be in this range. By way of comparison, last year private investment in Russia stood a little over 12 percent and public investment around 7 percent.
Russia's savings rate is already in the right ballpark. In the advanced emerging and transition economies, the savings rate seems to be positively associated with real GDP growth and financial deepening, and negatively associated with the budget deficit and the dependency ratio. These relationships suggest that Russia should settle down to a private savings rate of 20 percent of GDP.
3. How Do We Get There?
These considerations point to an obvious conclusion: the need to build on recent improvements in the climate for private investment. This involves both stability-oriented macroeconomic policies and further progress on structural reforms. The evidence in support of this conclusion is clear from the history of all the transition economies. Stabilization and structural reform both contribute to growth, and the more quickly and resolutely they are pursued, the better the economic outcome.
Of course, stabilization and reform were initially part of a painful and protracted process for Russia and the other CIS economies. Partly, this simply reflected the magnitude of the job that had to be done — and the fact that economic reform had to be accomplished alongside democratic reform and the building of a new nation. Given the scale of the task it is not surprising that "reform fatigue" has sometimes set in. Crucially, momentum was lost in the wake of the 1996 elections, when powerful vested interests strengthened their hold on political and economic power, deepening corruption.
Now, I am delighted to say, the reform process seems to be firmly entrenched, as the recent acceleration of structural reform illustrates. This is thanks in no small part to the long-standing courage and persistence of Russia's reformers, who are well represented in this room. I hope and believe that the IMF has also played some useful role in contributing to the current consensus in favor of macroeconomic stability, efficient markets, and integration into the global economy. But, fundamentally, reform is working because it is owned and driven by Russians themselves. This is not to say, of course, that vested interests have ceased to be a problem. Every opportunity to loosen their grip through greater transparency, institutional reform, market liberalization, and the removal of unjustified privileges should be taken when it can.
So what needs to be done now?
Macroeconomic policy is already in pretty good shape. The real exchange rate is bound to appreciate over time as productivity improves. But it is reasonable to seek to limit the pace of this appreciation, in light of the volatility of energy prices and their importance for the economy. This will help promote growth in the non-energy sector. Intervention with insufficient sterilization has undermined the reduction of inflation over the last couple of years. But the weaker external environment should lessen this conflict. Looking ahead, monetary policy should target a lasting cut in inflation. But administered prices should not be held down inefficiently to keep inflation down.
On the fiscal side, the strengthening of external and budget balances in recent years provides some scope for fiscal loosening in the near term, given the weak external environment. But this room for maneuver should not be used too quickly, given the uncertain costs of structural reform and the danger that weaker economic activity will reverse some of the recent improvement in tax compliance. In an effort to strengthen the long-term fiscal position, the authorities are rightly seeking to strengthen the Federal Treasury and its monitoring of local government finances.
Now what about structural reform?
Apart from major tax reforms, the structural reforms laid out by the government in July 2000 were running behind schedule as late as spring last year. Then, beginning with the adoption of measures to help the regulation and consolidation of the banking sector, the pace of reform has subsequently accelerated significantly. Through the remainder of last year, we saw welcome measures in a wide variety of areas, including: restructuring plans for railways and the electricity sector; a profit tax chapter for the tax code; a package of economic deregulation measures; a law against money laundering; a new land code; new regulations for housing and communal services reform; and, most recently, a new labor code, pension reform legislation, and elements of judicial reform.
The reform agenda for this year is broad and ambitious. First, it will be important to complete the reforms started last year, notably in pensions and judicial systems. In some areas secondary legislation and new regulations are necessary to put last year's reforms into effect. Second, new initiatives will be required to further improve the investment climate and make existing laws compliant with the requirements of WTO accession. I don't want to go through an exhaustive shopping list of what is being done and what needs to be done, but let me briefly mention four priorities.
First, financial sector reform. The 1998 crisis led to severe pressures on the banking system and to the disruption of the payments system. The recent strength of the economy has led to some improvement in bank balance sheets, but more fundamental reform is required to allow a strong and efficient banking system to develop.
As in other parts of the structural agenda, banking reform has received fresh impetus in recent months. The revised strategy paper approved by the government and central bank in December draws usefully on comments from a range of government, private sector and international institutions. It lays out a comprehensive framework for reform, although some important details remain to be spelled out.
The central challenge is how to stimulate competition in an environment dominated by a few large state banks. It is essential to level the playing field, so that state banks no longer gain a competitive advantage from the existence of a free and unlimited deposit guarantee that is not available to banks in the private sector. If a broadly based deposit insurance scheme were to be put in place — and there are a number of preconditions that would have to be met before doing so — this would increase the burden on supervisors and underline the need for consolidation in the sector. In the meantime, it is important that Sberbank is forced to operate on commercial principles.
In light of the challenges with which the authorities are grappling in this area, their decision to participate in a Financial Sector Assessment Program is welcome.
Second, property rights and judicial reform. These are important not only in their own right, but also as a way to encourage investment. Take the reform of bankruptcy law, for example. Strengthening the role of arbitration managers and stricter criteria for initiating bankruptcy proceedings will help eliminate abuse of the system for corporate takeover and asset stripping. Efforts to simplify and professionalize the court system will also help speed resolution of commercial disputes.
Third, the exchange and trade system. Russia needs to press ahead with measures to further integrate itself into the world economy. In the wake of the 1998 crisis, some exchange restrictions operated akin to capital controls and provided a breathing space while a coherent set of financial and structural policies were put in place. The authorities have used this breathing space well. International reserves have been built to record levels, helping improve Russia's position in its asset class and making it easier to tap international markets. But having done so, it makes sense to put in place a timetable for the removal of these restrictions.
On the trade side, the authorities have wisely made WTO accession a priority. Discussions intensified last year, supported by revisions to the tariff schedule. But much still needs to be done to make a variety of legislation WTO-compliant.
Fourth, and finally, the energy sector and natural monopolies. In both the gas and electricity sectors, the goal of market-oriented reform is to separate naturally monopolistic from potentially competitive activities. Currently the state retains a dominant role in both industries. The authorities have approved a reform plan for the electricity sector and proposals for the restructuring of the gas sector will be developed shortly. Reform has gone further in the oil sector, but here too the government is usefully contemplating further liberalization measures.
Let me conclude by noting once again that developments over the past year provide much reason to be optimistic about Russia's future. They testify to the underlying strength of the Russian economy as well as to the appropriateness of the policies being implemented by the authorities. Sound macroeconomic policies and resolute structural reforms are already bearing fruit. If they continue, then Russia will be well placed to fulfill its considerable economic potential.